Sandpile of the Century

Let’s suppose that in early 1997 an analyst had suggested to the governments of Russia, South Korea and Brazil that Thailand’s real estate market posed a systemic risk to their entire economies.  Let’s further suppose that the analyst had gone out on her limb and suggested that if the relatively small Southeast Asian nation began to face a potential market bubble-burst, the three giants should all pump in capital to bail it out in order to save themselves.  It’s not hard to imagine that our hypothetical analyst would’ve become a major laughing stock and even been recommended to seek psychiatric help for delusion.

Russia, South Korea and Brazil were three of the biggest emerging economies in the world at the time. Meanwhile, Thailand’s economy was only about 7 percent that of the three giants combined and its real estate constituted but a fraction of its relatively small economy.  As far as the three giants were concerned, Thailand was neither too big nor too interconnected to fail.  Any reasonable economist or financier at the time would be absolutely certain that Thailand—let alone its real estate market—was not a systemic risk.

Our hypothetical analyst did not, as far as we can tell, exist.  But had she been, she would’ve had the last laugh.  Thailand’s real estate bubble did burst and in an unpredictable chain reaction brought down the entire Southeast Asian economy with it.  The shockwave didn’t stop there; in a few months it destroyed South Korean economy and in a year it imploded Russia’s and pushed Brazil into a crippling economic crisis.

In The Age of the Unthinkable, senior geostrategic advisor Joshua Ramo contended that policy makers, politicians, and economists have been using arcane tools to predict what may or may not happen in today’s world.  They are akin to physicists who try to apply Newtonian physics—a science of certainty—to understand quantum mechanics—a world of probability.

Ramo argued that today’s systems—economic, political, or otherwise—are best described as what physicists refer to as a sandpile model.  The idea is that if you piled sand, grain by grain, until it formed a typical sandpile of a certain size, it would enter a strange “critical” state.  At first take, the sandpile would look like a stable system and you might be tempted to believe that you could predict whether the next single grain of sand would simply make the pile taller or cause an avalanche.  You would be wrong.

As a matter of fact, the sandpile is completely unpredictable.  If you had a thousand identical sandpiles and kept adding one grain of sand at a time on top of each, you would observe that some could hold thousands of grains before the sand started sliding off, some could hold hundreds, some could hold dozens, while others would experience avalanche just by one additional grain.  It is a system so complex that it would be impossible to make absolute predictions.  Such is the difference between Newtonian physics and quantum mechanics—at the quantum level, you can never say, “The particle is here and not there,” you can only say, “The particle has a higher probability of being here than there.”  And such is the difference between the economic system modeled by conventional economics and the actual economic system we are living in.

Unfortunately, it seems that arcane science prevails in Indonesia.  Respectable economists and financiers had claimed with absolute certainty before lawmakers that Bank Century did not pose any systemic risk to Indonesia’s financial sector.  Some gave a clear, black and white assessment that only fifteen banks, and no other, posed systemic risk.  They were absolutely certain—there was no room for unpredictability.   History would beg to differ.  A single grain of sand has caused avalanche plenty of times in this century.

In 1987, an accumulation of small factors—not one was considered a risk—led to a systemic shift that ripped apart the U.S stock market.  It happened again in 1997 in Asia.  And again just last year on a global scale.

Such unpredictability doesn’t stop at the financial sector.  Certainly a small country like Vietnam could never win an all-out war with the mighty United States; it did.  Certainly a small search engine company operating from a small garage could never beat a giant established company like Yahoo; Google did.  Certainly a housewife would never have a fighting chance in a legal battle against a giant hospital chain tens of thousands times as rich as she was; as far as everyone is concerned, Prita has already won.

Now our experts are very confident that Bank Century was neither too big nor too interconnected to fall.  Then again, neither was Thailand’s real estate market in 1997.

It is not our experts’ conclusion that we should be wary about, but rather the degree of certainty they place on the result of their analysis.  They failed to acknowledge that the systems in today’s world are so complex that such absolute prediction is simply ludicrous.  That our lawmakers and their advisers are still under the impression that they can make decisions based on solid predictions is a cause for concern.

Kwik Kian Gie resorted to a crude analogy and called Finance Minister Sri Mulyani a “frog professor;” an allusion to a learned scientist who is detached from the real world.  Yet if we choose to learn from history and sandpiles, one may wonder who the real frog professors are.  Is it those who acknowledge the complexity of today’s systems, adopt the principles of unpredictability in assessing situation, and make a judgment call to take swift action in order to prevent a possible cataclysm; or those who cling on ancient tools and dare to make absolute predictions in today’s world of complex systems?

An edited version of this article is featured in The Jakarta Globe

 

On the Externalities of Ied Exodus

This is the third in a series of articles on the economics of Ramadan.  The other two are on Ramadan-induced inflation and how charity can hurt the poor.

When I was little, Ied Al-Fitri was always one of the most fun days of the year, mostly because my entire extended family would all gather in one place to celebrate it.  The minimum set would be eighteen cousins, brothers and sisters, eight adults, and the matriarch, my grandmother.  As with a typical West Sumatran family, mine was all over the place and it always took quite an effort to move ourselves to a designated place.

That was about twenty years ago, when the Indonesian population was around three-quarters of today’s and urbanization was relatively limited.  At the time, while the traffic might increase during the ritual homebound exodus of Ied, it never reached the extent of what we experience today, where cars line up bumper to bumper, with swarms of motorcycles zigzagging wildly, mortally threatening everything in their paths, and where the length of a trip can quadruple that of any other given day.

Yet these days, under such excursion nightmare, hundreds of thousands still mobilize themselves every single year.  They are willing to wait in line for hours to get tickets; get cramped in busses, trains and ships, many without air conditioning; get completely stuck on the road; and literally risk serious injuries—and even death—due to accidents.

Irrational?  Actually we are observing quite a rational behavior.

Individuals take action after considering the personal cost and benefit.  For many of us, the cost of the annual homebound trip—which includes not only the actual fare but also the long hours, exhaustion, and risks—is worth the benefit of celebrating Ied with family.   When said individuals bear all the cost and reap all the benefit themselves, then whatever they decide is their own business.  The thing is, as we shall see, this is not the case with the annual homebound exodus.

Every time an individual decides to take the long trip home, they contribute to the traffic jam, which in turn put tremendous strain on the roads, which are built and maintained by our tax money, and inject tons of toxins and carbon into the atmosphere, poisoning the air and increasing global temperature.  Said individual would also significantly increase the risk of accidents happening, since with each additional bus, car or motorcycle on the street, the probability of collisions increases proportionately.  In 2008, the exodus saw over 1,300 road accidents with more than 600 fatalities, all occurred within a week, which constitutes about 100 deaths per day—had this been due to terrorist attack, drastic measures would’ve been taken.  These costs are not incurred on the individual deciding to join the exodus bandwagon, but on innocent bystanders.  And this is where the problem starts.

The additional costs of the Ied exodus that are borne on other people are more commonly known as negative externalities.  Exodus travelers only cover for the cost of tickets, fares, gas, personal time and physical exhaustion; while the rest of us cover for the cost of traffic jams, road damages, poisonous air, increased global temperature, and risk of fatalities.  These externalities should have been accounted for by the respective individuals when they weigh the cost and benefits of taking the homebound exodus; unfortunately, they are not.

In order to address the problem, the real cost incurred on the individuals taking the exodus must be increased, taking into account all the externalities.  This can mean taxing tickets and fares, setting up temporary toll booths on major roads, and even temporarily increasing gas price for several days before, during and after Ied.  The additional revenue should then be channeled to road maintenance, clean air campaigns, and deployment of additional police personnel.

Now you might protest because some people would then not be able to afford taking the trip home.  Well actually that’s the entire point.  Many people should decide that the cost—the true cost—of going home outweighs the benefit and choose to stay put.  Thus we would have less poison in the air and fewer deaths.  What is truly scandalous is the fact that not only the government—with our support—decides not to increase the personal cost of Ied exodus, it actually decreases it, by minimizing hikes in tickets and fares.  Since the cost of exodus is set considerably lower than it should be, there are significantly more people than it should be out there on the road.

The idea that there should be less people taking the Ied exodus is actually quite popular, especially if you’re one of the unfortunate ones who have ever experienced accidents on what is supposed to be a joyous occasion.  In 2008, the Indonesian Council of Ulemmas (MUI) considered making the exodus makruh—an action that is divinely discouraged.  Unfortunately, most people respond better to worldly incentive than divine sanctions.

I will not downplay the benefit of celebrating Ied with our loved ones.  Being able to share the love, joy, and a sense of triumph after a month fasting with the people you call home is truly a blessing.  But then again, is it worth 600 lives?

My extended family now numbers more than fifty.  Today we’ve made a conscious decision not to make it necessary anymore to have a big gathering during Ied.  Again, this is a rational decision—the cost, and risk, of having such familial exodus during the traffic peak of the year outweighs its benefit for us.  So we celebrate Ied in different places, making use of the wonder of today’s information technology to share our love and happiness with each other.  We do, however, agree to have a family gathering four times a year, scheduled deliberately outside Ied.  And we always have as much fun as we did twenty years ago.

An edited version of this article is featured in Jakarta Globe

 

How Giving Alms to Beggars Can Harm the Poor

This is the second in a series of articles on the economics of Ramadan.  The other two focus on Ramadan-induced inflation and the externalities of Ied exodus.

Begging on the street is haram—forbidden by divine sanction—and beggars will be cracked down by the authority.  At least that is what’s going to happen if the Indonesian Council of Ulemmas (MUI) and the Indonesian government can have it their way.

It appears that only several days into the holy month of Ramadan, major cities all over Indonesia are already flooded with seasonal beggars.  Seemingly as a response to that, the government announced that they endorsed all efforts to take beggars off the streets, including MUI’s move to declare begging haram.

I’m quite certain there will be people who would highlight how the MUI and government are misguided with their plans.  So allow me to focus instead on what I believe to be one of the main reasons—although most certainly not the only one—why we have the whole problem with beggars, especially the seasonal ones, in the first place: ourselves and our perverse sense of charity.

Let’s start from the beginning and make one thing clear: begging is a job.  Beggars may be officially referred to as the unemployed, but by all economic definitions, they are service providers.  Begging requires capital, time, and hard labor.  If you don’t believe me, try waiting on the side of the street for eight to ten hours a day in the baking sun, inhaling toxic fumes, while soliciting potential “clients.”  It also provides service; beggars supply us with a venue to delude ourselves that we’re helping the poor, compensate our sense of guilt for not helping enough, and—this is my personal favorite—help us secure a nice spot in heaven.  Ramadan allegedly doubles that last benefit; this perception, as we’ll soon see, pushes behavior with some unintended consequences.

Individuals choose jobs based on their personal cost-benefit analysis.  Beggars choose begging because it’s the “best” job for them; the job provides them with the highest return per unit time, taking into account the condition of the job market, the resources available to them, and the skills that they have.  The higher the return gets, the higher the attractiveness of begging as a job.  And many of us have done plenty to make that return really high.

While academic research is lacking, various journalistic investigations indicate that begging can bring up to Rp. 100,000 in one day. That’s about Rp. 2,500 per 15 minutes for a ten-hour day of work, which is quite a reasonable figure.  That income generation can increase dramatically during Ramadan, in which somehow a lot of people believe their alms are more valuable than in the rest of the months in the lunar calendar.  As a comparison, a car mechanic earns about Rp. 50,000 in average per working day.  Even if a person has other employable skills, begging would still be a very lucrative job.  So you can stop wondering why we have hordes of beggars, seasonal or otherwise; you might very well contribute to the phenomenon.

If that’s all there is to it, there should be no problem.  If begging is a legitimate job, let beggars beg.  But there are at least two serious consequences of seasonal begging.  First, they crowd out the urban poorest, who unlike the seasonal beggars have absolutely no alternative but begging.  Second, there is an increased use of children, either as beggars or as props, thus denying them of time for education and exposing them to extremely hazardous condition.  Many people’s tendency to give more alms to children and baby-carrying beggars is certainly not helping either.  Your alms during Ramadan, even if they really do increase your chance of going to heaven, end up depriving the poorest of the poor and endangering children back here on earth.

At this point I wish to make a disclaimer that I’m not making a case against giving.  Rather, I’m making a case against giving incorrectly.  My real contention is that it’s almost always better to channel your alms through respectable charity organizations than to give the same amount of money directly to beggars—at least if your intention is to really help the poor.

Charity organizations that channel alms can do so more effectively than individual alms-givers.  The pooled alms that they manage are significantly large that they can use them to fund well-planned programs, both short and long-term, that are more sustainable.  Most of such organizations do more than simply help the poor survive day by day; they also have an eye on the horizon, providing financial assistance for education and even capital to start small businesses.

If you still prefer giving directly to beggars because they’d get all your money without having to pay the service of a middle man, think again.  Like any underground economic sector, seasonal beggars are organized.  And they have to pay a fee for the “organizers.”  Under such arrangement, a beggar would typically get a meager 30 percent of what they earn.  An accountable charity organization would spend most of your alms on their targeted beneficiaries; and they would show you their financial report to prove it if you asked for it.  Give directly to beggars and you’d most likely give less.

At the end of the day, perhaps the best litmus test is your own conscience.  So the next time you feel the impulse of giving small change to street beggars instead of giving the same amount of money to a respectable charity organization, ask yourself, “Am I doing this because I really want to help them and I’m certain that my petty coins would bring a significant impact to them, or am I doing this simply to make me feel good about myself and perhaps increase the probability of securing a nice place in the afterlife?”

Then again, if MUI and the government push forward with their respective plans, we might not have the opportunity to ask that question at all.

An edited version of this article is featured in Jakarta Globe

 

The Economics of Ramadhan

This is the first in a series of articles on the economics of Ramadan.  The other two discuss how charity can harm the poor and the externalities of Ied exodus.

I started fasting at a very young age. Not necessarily out of extreme piousness, but rather because I wasn’t much of an eater and was only too grateful to be allowed not to have lunch for an entire month. On top of that, by a five year-old’s logic, I believed I was doing my parents a big favor by cutting down expenses for food.

That five year-old’s logic is turned completely upside down by reality. As a matter of fact, households’ expenses in Indonesia, as well is in other predominantly Muslim economies, increase quite significantly during Ramadhan. Apparently, during the holy month, the overwhelming majority of Indonesian households increase their consumption, which pushes up demand, thus increases price. So not only do households buy more stuff, they buy them at higher prices.

If there are still people out there who are skeptical that Ramadhan induces higher inflation, governments of predominantly Muslim countries all over the world are certainly not. From Indonesia to Jordan, governments recognize the immense increase in demand and are already rushing to intervene the market by either upping supply or imposing ceiling price. However, even with such relatively massive intervention, the demand shift is usually too significant and higher inflation is inevitable. Indonesian Trade Minister Pangestu already found 11 to 33 percent increase in price of foodstuff in Bandung a day before Ramadhan started.

That price increases because of rising demand is basic economics; that demand increases during what is supposed to be the month of frugality is nothing short of an irony.

The major culprits behind this demand shift are likely to be the middle and upper classes, who have the means to consume more. What really causes the consumptive behavior is up for grabs. One explanation is that we are all too sensitive to our loss of utility—loosing meals during the day—and overcompensate it by consuming more in the evening and during Ied. A more common term used for this hypothesis is balas dendam—avenging for our loss.

Or perhaps it is impulse buying and herding movement—we see everybody else eating out, having feasts with friends and family, and we are compelled to join the wagon. It’s quite easy to justify these impulses by saying that it’s all in the spirit of strengthening silaturahmi or bonds among the ummat.

Regardless of what really caused demand-pushing behavior, what we really need to understand is that the significantly higher inflation during Ramadhan hurts the poor tremendously. Most of them do not work as traders and would not feel the benefit of the inflation. Yet they would certainly feel the impact of increased price, especially of basic goods. Cutting down both quantity and quality of food is often the only option.

Worse still, in the effort to reap benefit from the inflation, some traders would be compelled to sell damaged goods at lower price; and they would certainly find buyers. Nearing Ramadhan, officials from Jakarta had raided a number of stalls in traditional markets that sold spoiled chicken and meat. It is the poor who would most likely buy and consume these damaged goods, and later suffer the consequences.

To be fair, demand shift and inflation are not the only Ramadhan-induced economic phenomena. While an in-depth analysis of aggregate data is required to validate the following statement, anecdotal evidence indicates that the holy month also brings about increased redistribution of wealth. It is after all the month of charity.

However, increased alms-giving, be it compulsory like the zakat or voluntary like the sadaqoh, would only significantly benefit the poor in a low-inflation economy; and as we have seen, this is not the norm during Ramadhan. Coupled with inflation, alms would most likely only help the poor maintain their purchasing power, but not increase it.

Furthermore, while inflation affects the entire population, alms tend to be targeted to only small pockets of the same population. Hence, though there would indeed be poor households who received assistance in coping with the inflation, most of the lower class population would only feel the full-blown effect of increased price without receiving significant support from the redistributed wealth.

In the light of everything, the middle and upper classes would actually help the poor more by not spending than by giving.

So all this leads the Muslim middle and upper classes to two options. If we really wish to help the poor during the holy month, we should increase expenses for alms and decrease—or at least maintain—consumption by refraining ourselves from hosting or going to feasts at the daily break of fasting, as well as during Ied. We should also decrease consumption by avoiding eating out and refraining, or at least deferring, expenses to buy new clothes.

This would help lessen the demand shift, thus lowering inflation, and at the same time increase the poor’s purchasing ability. This would also—and perhaps this is the most important thing—be more consistent with the spirit of Ramadhan, in which frugality is supposed to trump extravagance and contentment wins over dissatisfaction.

The second option is to give in to our impulses and oversensitivity to loss of utility. We can continue increasing our spending for food during the holy month. We can go from one feast to the next and host one in between. We can, in effect, significantly increase demand and raise price, and justify that by saying that it’s all in the name of strengthening silaturahmi and bonds with family and friends.

During all that, we can make us feel good about ourselves by increasing alms and providing meals for a small group of poor families in the evening. Opt for this, and we would at best maintain the utility of a small group of poor people at the same level, while making life harder for most lower class households in the country.

Sadly enough, in this holiest month of the year, we would most likely observe the latter scenario.

An edited version of this article was featured in Jakarta Globe